Friday, October 26, 2012

McKesson Buys PSS: Channel Consolidation Carries On

Yesterday, McKesson (NYSE: MCK) announced plans to acquire PSS World Medical (NASDAQ: PSSI), paying a 34% premium over Wednesday’s closing stock price. Read the press release.

This acquisition is another solid deal for McKesson. The combined companies will have about 28-30% of the ambulatory (non-acute care) medical-surgical distribution business. Cardinal Health will be distant second, with less than 10% of this business. As with US Oncology, the acquisition once again allows McKesson to snatch another likely target from Cardinal. At a more than-12X multiple of EBITDA, the deal is pricey. [NOTE: EBITDA multiple corrected from earlier version.]

For manufacturers, distributor consolidation once again blurs competitive boundaries between business partners. Companies with both pharmaceutical and vaccine portfolios will feel the most pressure. Read on for a quick look at the med-surg market and the transaction.


The distribution of pharmaceuticals to primary-care physician offices and other non-acute settings occurs primarily via the medical-surgical supplies distribution channel. Major national distributors include subsidiaries of McKesson and Cardinal Health, along with Henry Schein (NASDAQ: HSIC) and Medline (private). About half of the market is serviced by a boatload of local companies. This channel’s trade association is the Health Industry Distributors Association.

Major drug products used or administered in the physician’s office include vaccines, inhalants, ophthalmic ointments and solutions, antibiotics, and injectable anesthesia agents. In its 2012 fiscal year, pharmaceuticals accounted for about 22% of PSS’s revenues.

Private label products are 15% of PSS’s sales, up from 9% in 2006. Due to this mix, PSS’s gross margins have been about 33%, versus about 3.4% for core drug distribution. However, cost-to-serve is much higher, so overall operating margins are 6% to 7%. In its May Investor Day presentation, PSS estimated the size, growth and margin of its major markets as follows:


PSS will be integrated with McKesson’s existing Medical-Surgical Distribution sub-segment, which supplies medical-surgical products, equipment, and other services to alternate-site healthcare facilities. These include physician offices, clinics and surgery centers, long-term care facilities, occupational health facilities and homecare sites. McKesson's reported medical-surgical segment includes ZEE Medical, a van-based provider of occupational first aid and safety products, training, and services to manufacturing plants, offices, construction sites, restaurants, and hotels. This van-based approach mirrors the PSS distribution model, although it's a fundamentally different market.

Pre-PSS, the med-surg business accounts for 2.6% of McKesson’s revenue, but 6.5% of its Earnings Before Interest and Taxes (EBIT). See Exhibit 54 (page 106) of the 2012-13 Economic Report on Pharmaceutical Wholesalers

Through acquisition, PSS has built a ~$100 million (FY2013 run rate) in-office dispensing business. McKesson has been investing in oral oncology dispensing solutions for its specialty business, so it will be interesting to see whether McKesson tries to grow the business further. In 2008, McKesson sold off its institutional pharmacy outsourcing business. BTW, PSS has claimed to have stayed away from in-office dispensing’s controversial business practices, as described in The Incredible Economics of Physician Dispensing.

A med-surg distributors can influence a product's market share much more than a pharma wholesaler can, so the combination portends much more pressure on manufacturers and other suppliers. Keep an eye on the transition plans.


  1. I know PSS well, having been associated with it for 27 years (and no longer so). McKesson is acquiring a first class company that will add incremental revenue over the long term. I know they've wanted it for a long time. Glad to see PSS went with McK and not Cardinal.

  2. Nice write up Adam. On the mark. I started PSS's drug distribution business in the mid 80's. As the company grew from a statewide to regional to national player, they did things right (most of the time). First class leadership and if McKesson let's their customer service model flourish, they will capture an even greater share of the alternate care market and fit nicely into drug distribution into that market.

  3. Any thoughts on Athena Health? Will McKesson dump them for its own products?

  4. PSS was a big reseller of Athena's products. Over time, I expect McKesson to focus on its own IT offerings vs. a third-party resale deal. However, this won't happen overnight. 

    Here's what McKesson CEO John Hammergren said yesterday when asked about Athena:

    "And at the end, even to the extent that we might have some competition with McKesson's internal capabilities across the footprint, we're not going to -- out of the gate discourage any or dismantle any of the relationships that PSS World Medical has built without careful evaluation. Athenahealth has built a great model, I know the team there. And their model, frankly, is a little different than the model we have in our REMS business. We have a different physician practice target that we're looking at compared to what they're doing, and so I wouldn't jump to any conclusions.

  5. Schein may very well purchase Physicians Total Care before McKesson/PSS does.  It would completely sidetrack this move McKesson is trying to make. Physicians Total Care has the manufacturing NDC's and software  that would take McK/PSS 3 years to create.  Somebody will crush this move, cant wait 'til they do.  Has to happen by the 31st.  Happy Halloween, McKesson. Tricks not treats.